Submitted by Mark J. Grant, author of Out of the Box,
I have long held the opinion that the markets, all of them, have been buoyed by what the Fed and the other central banks have done which was to pump a massive amount of money into the system. There are various ways to count this but about $16 trillion is my estimation. The economy in America has been flat-lining while the economies in Europe have been red-lining and while China has claimed growth their numbers did not add up and could not be believed.
In other words, the economic fundamentals were not supporting the lofty levels of the markets which had rested upon one thing and one thing alone which was liquidity. I have also stated often enough that the long awaited reversal would take place either due to an "event" or due to a change in the Fed's position where the liquidity was going to be stopped. In one of the clearest and most open meetings ever conducted by the Fed, in my opinion, they said quite clearly that the end to its liquidity operations was coming and while the postulated this and that if the markets did this and that the message was quite clear; we are going to unwind what we have we have done.
Yesterday was the first day of the reversal. There will be more days to come.
What you are seeing, in the first instance, is leverage coming off the table. With short term interest rates right off of Kelvin's absolute Zero there was been massive leverage utilized in both the bond and equity markets. While it cannot be quantified I can tell you, dealing with so many institutional investors, that the amount of leverage on the books is giant and is now going to get covered. It will not be pretty and it will be a rush through the exit doors as the fire alarm has been pulled by the Fed and the alarms are ringing. There is also an additional problem here.
The Street is not what it was. There is not enough liquidity in the major Wall Street banks, any longer, to deal with the amount of securities that will be thrown at them and I expect the down cycle to get exacerbated by this very real issue. Bernanke is no longer at the gate and the Barbarians are going to be out in force.
Yesterday was not pretty but today is likely to be worse. Gold is getting smashed, equity futures are down significantly, bonds are taking it on the chin and the only thing that is up is the Dollar. Then besides the Fed's announcement; China is a rose dying on the vine. Their overnight repo rate hit 25% as the fear is palpable in Asia between the collapse of the Everbright Bank and the antics in Japan. The yield on China's three year government bonds rose 12.5% last night while their flash PMI plunged to 48.2 which is the worst number in nine months.
Now you may be wondering what to do next. You will hear a lot of people in the media today saying that this is just a normal part of the market's cycle.
This is not the case.
The Fed has signaled its intentions very clearly. You should be taking profits, taking money off the table and building up your cash positions. Your supplier of opiates has just informed you that your drugs are going to get cut off and preparations need to be made because there is no other supplier of this opiated cash. You can accurately think of the world's central banks as a "cash cartel" and the distribution is being ended.
How bad it is going to be is uncertain but BAD, with capital letters, in my estimation. For four years we have lived on drug money supplied by the Fed and their colleagues and what the emperors' can give; they can take away.
Eventually Treasury yields will go back down because the Fed will be buying more bonds than the Treasury needs to issue but for now the "leverage issue" will overcome that reality. Mortgage rates will be heading higher, the Real Estate market is going to correct and the days of wine and roses are now behind us.
The party is over!
"It's my party, and I'll cry if I want to
Cry if I want to, cry if I want to
You would cry too if it happened to you"